Italian mess shows why the Brits voted Leave

There is a crisis in Italian banking and the cheapest, most efficient way of solving the crisis is an Italian govt bail-out. But EU “rules” are “preventing” this. EU wants the retail investors in bank bonds to take a hit.

With a friend like EU, who needs enemies.

From NYT Dealbook:

ITALY’S PLAN FOR BANKS IS DIVIDING EUROPE The Italian government needs to spend an estimated $45 billion to shore up its banks, which are burdened with bad loans. But fears that European authorities will bar the government from providing this support is adding to turbulence in the aftermath of Britain’s vote to leave the European Union,Peter Eavis reports in DealBook. And the situation could keep investors on edge through the summer.

Italian bank shares have dropped steeply – an indication of a storm ahead. The stock price of Banca Monte dei Paschi di Siena, one of Italy’s most troubled lenders, is down 80 percent in the last 12 months. Its shares trade at under 10 percent of its book value – a sign that investors really think that the bank needs new capital, although when bank stocks sink that much, they find it almost impossible to raise new capital on the markets.

Italian banks don’t appear to need an overwhelmingly large sum to return them to a firmer footing. The problem is their 200 billion euros, or about $222 billion, of bad loans. The banks have already set aside significant reserves to absorb losses in these loans, effectively valuing them at 40 percent of their original value, according to some analyses.

But investors appear to think that the loans are worth less than that, and the theory is that banks would have to value the loans at an even lower level.Banking experts say that €40 billion of support is needed to help the banks take those losses.

The Italian government could mimic the United States government’s TARP spending in 2008 and plow that money into the banks, but a bailout of that sort may be illegal under relatively new European rules that aim to protect taxpayers.

The rules aim to force investors in the banks to provide support in times of trouble by buying their debt securities. Under anti-bailout rules, these securities would be forcibly turned from debt into new equity, which could absorb any new losses taken on the bad loans. Under such a so-called bail-in, the equity would in theory be worth less than the debt securities, leading to losses for investors who held the debt.

In Italy, however, retail investors hold many of these debt securities– families own about a third of them, according to the research organization Bruegel. A bail-in would focus the pain on Italian households, and the fear of losses might also prompt investors to stop lending to banks and lead depositors to withdraw their money.

A compromise with Europe’s leaders does not look impossible, although there is considerable tension over the question.

The rules provide ways to give Italy a pass, but Cassa Depositi e Prestiti, a large investment entity controlled by the Italian government, could also provide bailout funds. Either way, analysts agree that the government would have to overhaul the industry.